Lower middle market focused BDC Monroe Capital Corporation
(MRCC) ended the IIIQ 2016 with 6 of its 66
portfolio companies under-performing to varying degrees. In aggregate, Watch List asset are valued just over $20mn, and are equally divided between the three tiers the BDC Credit Reporter
uses to assess risk. Only 1 Watch List company (TPP Acquisition)
is on non-accrual,
and tagged as Non-Performing, and accounts for a third of the total in dollar terms. That's a Great Experiment for MRCC, which intends to bring the company out of bankruptcy, with a new capital structure and potentially, even more capital. Some portion of the debt currently on non-accrual for 3 quarters may return to paying status. Watch this space.
There is one more Category 5
company in the portfolio. The internet publisher Answers Corporation
(now known as Multiply) is already not paying its second lien lenders but MRCC's share of a syndicated First Lien loan is still current, but probably for not much longer. Thankfully for MRCC, the Answers exposure is not a Material Position by our reckoning (i.e. under 1% of Net Asset Value).
There are two Category 4
companies in the portfolio. The other two are both long-standing "troubled credits: Fabco Automotive
has been valued below par since 2013 and has just seen its Unitranche loan (which itself was just restructured and re-priced) written down by a record 51%. The investment size is equal to 1.7% of NAV. Shoe company Rocket Dog Brands,
in which MRCC has invested senior and subordinated debt and Preferred and common stock, has been on Watch List Status since 2012. Still, remaining exposure is only just over $1mn (from $4.5mn at cost) and 0.5% of NAV. For both Fabco and Rocket Brands the credit trend is still down in the IIIQ of 2016. The Category 4 names, though, contribute only a modest amount to MRCC's overall income. (Nonetheless, we wonder how MRCC can justify booking about $0.5mn of annual income on $3.5mn of Rocket Dog investments at cost-all in PIK form- so we'll be asking Investor Relations). Fabco pays a mixture of cash and PIK.
Finally, there are two Category 3
credits: on the Watch List but more likely than not to still meet all obligations in full: BluestemBrands, Inc.
and Playtime, LLC.
Both have been written down modestly and are very much paying their bills. Nonetheless, we will remain vigilant.
Overall, MRCC's credit quality appears to be in good shape by most any standard at the moment, with Watch List assets accounting for just 8% of September 30, 2016 Net Asset Value. The BDC Credit Reporter, though, worries both about the strategy of doubling down on bankrupt companies by investing even more time and capital therein; and by the possibility that one or two companies are being "kept alive' for long periods by PIK-ing or reducing debt obligations, but do not have business models with a reasonable hope for success, which we shall call "Zombie Companies". Other than those concerns, MRCC's relatively short history as a public company has resulted in a remarkably clean sheet where net investment losses are concerned, with Realized and Unrealized Losses less than 1% of equity capital at par.
After many quarters of balancing on the brink, Bluestem Brands Inc. has filed for Chapter 11. In a press release, the retailer indicated its commitment to remaining in business through the bankruptcy process, and the arrangement of a $125mn DIP financing by a “syndicate of lenders”. The “syndicate” is also serving as a “stalking horse bidder” for the company’s assets, and seeks to de-leverage and restructure the company’s balance sheet.
Who are the members of the syndicate ? Not disclosed. What might the assets be valued at ? Not mentioned ? How much debt might be wiped from the balance sheet ? Still to be determined. Nonetheless, this seems to be a classic debt-for-equity swap where the lenders become part, majority or the exclusive owners of the new Bluestem Brands. Sometimes that works, and sometimes not.
We’ve been writing about Bluestem Brands for a very long time, both in the BDC Credit Reporter and in our database of all under performing BDC companies that we maintain. Barely a week ago we wrote to ourselves the following summation of our views:”3/4/2020: We worry that Bluestem might be about to meet its moment of reckoning in 2020 with the need to repay its publicly traded Term Loan in November 2020 and its modest liquidity above the mandated level at the end of the IIQ 2019. Sales and EBITDA trends are either anemic or negative. The debt is already discounted by nearly a quarter. As a result, we’ve added the company to the 2020 At Risk Of Non Accrual list.”
Now that’s happened we’ll be interested to see what the 4 BDCs with $28.2mn of exposure at cost – Main Street (MAIN); Capitala Finance (CPTA); Monroe Capital (MRCC) and non-listed HMS Income – will be doing. We imagine they are committed to a portion of the DIP financing and are likely to end up as owners, and may also be committing more junior capital. As mentioned above, we don’t know how much historical debt will be forgiven. So any sort of valuation is hard , but Advantage Data shows the 2020 Term debt in which all the BDCs are invested trading at a (29%) discount; just slightly worse than the recently announced IVQ 2019 (25%) discount announced by the three public BDCs. That suggests, but does not guarantee, the eventual realized loss to be taken might be over ($8mn). In an earlier article, though, we’d been estimating ($15mn). More immediately, income forgone will be about ($1.4mn) annually, mostly absorbed (4/5ths) by sister BDCs: MAIN and HMS Income.
We will report back as we learn more about how this bankruptcy will play out, and what individual BDC exposures to old and new capital (if any) will look like.
Just in case you didn’t know, it’s the companies themselves who pay for their credit ratings from groups like Moody’s and S&P. (That’s different than at the BDC Credit Reporter, whom nobody pays). We were reminded of this economic fact of life on hearing that Moody’s has “withdrawn’ the ratings of retailer Bluestem Brands. The rating firm – usually prone to long discussions in its regular credit reports – was succinct on this occasion: “Moody’s has decided to withdraw the ratings because of inadequate information to monitor the ratings due to the issuer’s decision to cease participation in the rating process“. No other explanation was given.
Apparently S&P Global has not been any kind of succor. That rating group downgraded the company on January 28, 2020 to CCC- from CCC..Here’s the crux of the matter as S&P sees it: “
“Bluestem’s revolver and term loan are due this year and we believe the likelihood that the company will undertake a restructuring in the near term has increased. The company’s $200 million asset-based lending (ABL) facility matures in July and its term loan (roughly $400 million outstanding) comes due on Nov. 7, 2020. In our view, Bluestem does not have a clear refinancing plan and we believe it is increasingly likely that the company will pursue a holistic debt restructuring to address its maturities given its weak operating performance. If the company pursues a restructuring or exchange that provides its lenders with less than they were originally promised under the security, we would view it as distressed and tantamount to a default”.
We’ve written on three earlier occasions about Bluestem, starting back in the spring of 2019. As far back as June 2019, we had a Corporate Credit Rating of 4 on the company – on our five point scale. More recently, when we began projecting out which BDC-financed under-performing companies were most likely to default in 2020, Bluestem was one of our first additions. Now there seems to be a consensus building that the company will not be able to avoid either a “distressed debt exchange” or a Chapter 11 filing in the months ahead.
For the 4 BDCs involved – all in the 2020 Term Loan, which is structurally subordinated to the Revolver (as far as we can tell) – that’s bad news. Not helping is that S&P is only projecting a 45% recovery rate in event of default. That implies ultimate losses of over ($15mn) over cost, or about ($6mn) more than already provided for at September 30, 2019. Then there’s the $2.7mn of annual investment income at risk of interruption…
We expect to be revisiting Bluestem – and its intractable balance sheet inside a retail sector in seemingly permanent crisis – before long.
According to a trade publication, The Worth Collection may be in the process of “winding down”. The women’s apparel company’s website is no longer operational according to the report, which checks out. Apparently, there has been a broad campaign to raise additional capital or find a buyer but with no success. The company is owned by PE firm New Water Capital following a purchase in 2016.
Publicly available information is sparse at this point, as much of the pertinent information is behind a paywall. However, we did already know that the company’s debt was placed on non accrual in the IIIQ 2019 by its only BDC lender Monroe Capital (MRCC), which wrote the 2021 Term Loan down (34%). As of now that same debt is trading at a (36%) discount according to Advantage Data’s Syndicated Loans records. The exposure was first initiated in 2016, presumably in conjunction with the New Water acquisition.
This is setting up to be a material reverse for MRCC, which is already missing out on over $1.0mn in annual investment income. The BDC may have to write off anywhere from a third to all of its $10.4mn investment. There may be some value in the brand or other assets, but maybe not. We expect to hear something more official shortly.
We pride ourselves on being timely about alerting readers to material new developments at under-performing BDC-financed companies. In this case, though, we’ve been slow to notice the deterioration underway at iconic restaurant chain California Pizza Kitchen (CPK). In July and August 2019, the company was downgraded by both S&P and Moody’s to speculative grade status. Here’s a sample of what the former said: “We are downgrading CPK to ‘CCC+’ from ‘B-‘ to reflect our view that the company’s capital structure may be unsustainable over the long term.
Moody’s said the following: “CPK’s Caa1 Corporate Family Rating is constrained by its high leverage, modest interest coverage, small scale and geographic concentration relative to comparable casual dining concepts. The company is further constrained by the challenging operating environment which includes soft same store sales growth, with weak traffic trends, and increased labor expense as a percentage of restaurant sales which continue to pressure profitability margins“.
All the above notwithstanding, the 2022 and 2023 Term debt in which seven BDCs have committed $48mn was still valued at a discount of less than (10%) last time results were published in September 2019. As of June 2019 the debt was trading (almost) at par. As of now, though, the publicly traded 2022 Term Loan is trading at a (12.5%-15%) discount, and the more junior 2023 facility at (20%) off. Time to get worried about the $5.0mn of annual investment income that is being generated for the BDCs involved.
There are 6 public BDCs with material exposure, led by Main Street (MAIN) and followed in descending dollar amount by Great Elm (GECC); Monroe Capital (MRCC); Capitala Finance (CPTA); Capital Southwest (CSWC) and Oaktree Specialty (OCSL) – a veritable potpourri of funds with little else in common. There does not seem to be any immediate risk of default, although Moody’s did suggest there was a potential need for a covenant waiver or amendment at year end. That may not have been required or has been granted or could be under discussion. We have a Corporate Credit Rating of 3 on CPK on our 5 point scale, but that could move down quickly in 2020 if performance does not turn around – which seems unlikely – or if PE owner Golden Gate Capital, which bought the famous chain in 2011, does not inject new capital.
We admit the BDC Credit Reporter has been a bit slow to flagging CPK’s credit troubles, but expect to hear much more from us in the months ahead if the company’s debt continues to drop in value. We will say that we’ve been concerned about negative trends in the restaurant sector since late 2018. We’re not yet at the “apocalypse” phase attached to anything in the retail sector, but there are several secular trends – referred to by Moody’s above – that even the best and the brightest restaurant chains are having trouble working through. When you’ve got debt to EBITDA levels of 7x or more – as is the case with CPK and many others – the room for maneuver before a restructuring becomes necessary is limited.
For five consecutive quarters Monroe Capital (MRCC) has carried its loan to Education Corporation Of America (ECA) as non-performing. Finally, the BDC – and other creditors – has asked the court to force the for-profit education company into involuntary bankruptcy in Delaware. This is one more step in the slow unwinding of the company. In December of 2018, ECA lost its accreditation and closed campuses all around the country. Subsequently, MRCC bought one of its schools – the New England College of Business – back in May 2019. On MRCC’s books this is now carried as a separate portfolio company. The BDC has $2.2mn in first lien debt and equity invested in the newly acquired education firm which we’ve rated CCR 4. In the IIIQ 2019, the equity value of the MRCC position dropped to $1.1mn from $2.6mn in the prior – inaugural – quarter. That’s not a good sign and given the BDC’s mixed history in this space and the challenges the for profit segment faces, we added New England College to the under performers list.
Back to ECA. That company has been managed by a court appointed receiver for months. Now, for reasons that are not yet clear to us, MRCC and other creditors want a final resolution of this situation. The BDC has $8.2mn at cost invested in ECA, in the form of debt and preferred. Mostly the latter. Interestingly, the BDC still valued its investment at just under $6mn as of September 2019. The creditors may believe there is still some value tied up in the business that might be unlocked by a bankruptcy process.
If the court does accede to the request, the fate of MRCC’s investment in ECA should be known soon. How the New England College Of Business spin-off plays out may take longer to clarify. In any case, this has been a tiresome episode for the BDC, which became involved with ECA and the for profit education sector back in 2015., and which went sideways in a hurry. As recently as March 2018 the investment was valued at par, as Advantage Data’s records show. We added ECA to the under performers list only in the IIQ 2018 and because the preferred was written down a modest (12%). The next quarter ECA was on non accrual. MRCC will likely have to book an eventual Realized Loss of anywhere from ($3mn) to ($8mn). We will undertake a fuller post mortem of the ECA investment in the future once the matter is closed out.
This is where the BDC Credit Reporter meets the Sopranos: On December 9, 2019 we hear from multiple news outlets – who love this sort of material – that the Director of Development at real estate company HFZ Capital has been fired. Apparently, the individual in question has been charged by prosectors with working with organized crime to siphon off hundreds of thousands of dollars from New York real estate projects in which HFZ was involved. We should note that the Director Of Development has pleaded not guilty.
This is what the company had to say about the episode: “In a statement, HFZ said it, along with other developers in NYC, learned of the investigation into CWC months ago and removed CWC from its projects. “HFZ immediately terminated Mr. Simonlacaj’s employment upon learning of the allegations against him, which run contrary to the values of the firm and how its business is conducted,” HFZ said.”
More disturbing from a credit standpoint is that this individual had been convicted of an earlier offense and spent 3 months in prison and been vouched for by one of the owners of HFZ as recently as 2016…
The only BDC with exposure to closely held HFZ is Monroe Capital (MRCC) which had two term loans outstanding – due in 2019 and 2021 respectively – with a cost of $23.2mn at September 30, 2019. At the time, the loans were carried at par. However, both loans appear to be publicly traded according to Advantage Data records. The 2019 loan has already reached its maturity and has – presumably – been repaid. However, the 2021 loan was last priced at a (44%) discount to par. MRCC has $5.1mn invested at cost in debt with a face value of $9.0mn.
This is the first time we’ve familiarized ourselves with HFZ Capital – a well known developer in New York who’s seeking to build a huge project in the High Line funded by a hedge fund – and there’s much more to learn. Right away, though, we are giving the company a Credit Rating of 4 – our Worry List – due to the very serious charges brought against one of its top executives and the valuation of the 2021 debt.
We’ve written about Bluestem Brands before on two occasions, on April 12, 2019 and June 19, 2019. Now the multi-name retailer – whose results are publicly made available every quarter – has just completed its IIQ 2019 results. Unfortunately, the turnaround at Bluestem continues, and there are signs that the situation is getting a little worse. We won’t undertake an in-depth diagnosis, although we’ve reviewed both the earnings press release and the Conference Call transcript.
We’ll focus on a key metric – and one of two material debt covenants. Required minimum liquidity – demanded by the senior lenders – is $40mn. This quarter, Bluestem had $50mn, down from $59mn the prior quarter. That’s pretty close, and principally why we’re writing this update.
We have a Corporate Credit Watch of 4 (Worry List) for the company, which has been “troubled” since 2016. The latest results don’t change our rating, but we continue to worry that the company is just one reverse away from a covenant default. That would not be the end of the world, but might suggest the attempt to turnaround the business with its current capital structure is unfeasible. That might involve some debt haircut in some form. Given BDC exposure of $29mn – already discounted – by (23%) by 3 of the 4 BDCs, there could be some further Unrealized Losses to come in the short term.
(We should point out that – for reasons unknown – Capitala Finance (CPTA has only a (4%) discount on its share of the 2020 senior debt, one sixth of what Main Street Capital (MAIN), HMS Income and Monroe Capital (MRCC) have valued the same exposure. There’s been a deviation between CPTA and the other BDCs for several quarters, and we don’t know why. If matters do get worse, CPTA – with $3.7mn of debt at cost – has the farthest to fall).
On June 18, 2019 multi-unit retailer Bluestem Brands reported results for the quarter ended May 3, 2019. We reviewed the earnings press release, and the Conference Call transcript on Sentieo (not yet linkable). Notwithstanding lower sales in the period compared to a year earlier, the company reported progress in “turning around” the business in several areas. Adjusted EBITDA was barely positive but that’s an improvement over ($12.6mn) a year earlier. Most importantly, from a credit standpoint the company was nowhere near triggering the several key metrics imposed by its senior lenders. Nonetheless, the burden of total debt has remained unchanged over the past several quarters, and its principal Term debt becomes due in late 2020. We have a CCR 4 Credit Rating, which remains unchanged. There are 4 BDCs with $29mn in exposure – all in the 2020 Term debt. In the IQ 2019, the unrealized depreciation was reduced in the BDC valuations and may receive a modest boost in the IIQ, based on these results. Nonetheless, the retailer is far from being out of the woods.
The troubled e-commerce retailer published quarterly and annual results for the period ended February 1 and 2, 2019. Despite closing down several brands and taking one-time losses, the Company’s Adjusted EBITDA and key bank covenants, as well as liquidity, all appear better. May stop the gradual erosion in BDC debt values underway since late 2016, which peaked in IVQ 2018. We updated the Company file and the BDC Credit Reporter’s views accordingly. For all the details, see the Company File.